Diversification – the rules of thumb

Diversification means spreading your money between different types of investment.

Whether it’s types of companies, types of asset – like shares, bonds, funds and property – different parts of the world, or investment styles, there are lots of ways you can do it.

It’s important not to put all your eggs in one basket. We always suggest investors spread their money across a range of investments.

There’s no hard and fast rule for how many investments you should hold in a portfolio. Too few can add risk, while too many can be hard to manage and mean any gains in excess of the benchmark are diluted. As a rule of thumb we’d suggest holding no more than 20 funds. For most investors, about 10 funds could provide a well-diversified portfolio.

This article isn’t personal advice. If you’re not sure if an investment is right for you, please speak to us – we can put you in touch with a financial adviser.

But not 10 of the same

Holding lots of investments doesn’t mean your risk is spread properly. The investments need to be different. Holding shares in ten different banks might feel diversified, but if that sector takes a hit, so will your portfolio.

Instead, focus on variety. And this could mean putting your money into companies or funds which aren’t doing well right now, which could be uncomfortable, but investing is a marathon. When the tide turns, and it usually does, you might well be in the right place to benefit. Remember all investments can fall as well as rise in value, and you might not get back what you invest.

Funds naturally provide some diversification by holding a spread of investments, reducing the risk from any one on its own. But one fund isn’t usually enough.

Funds with a narrow focus – like geographical or sector-specific funds – will often see their values move as one in response to what’s going on in the market. With all the assets moving in the same direction at the same time, investors could still face dramatic movements in the overall value of the fund.

The dangers of over-diversification

Despite the advantages of a diversified portfolio, too much diversification can hinder, rather than help, performance.

A very large number of holdings risks copying market performance. Each holding doesn’t make up a sufficient proportion of the overall portfolio to have a significant impact on its performance. Not only does this offset any benefits from picking good investments, but an index tracker fund could be considered as a lower-cost alternative to having lots of actively managed funds that invest in the same area.

How to stay on top of diversification

It’s important to regularly review and, if necessary, rebalance your portfolio to make sure it still meets your objectives. When you get closer to retirement, for example, depending on which retirement option you choose, you could consider letting go of some higher-risk investments and focus on lower-risk investments to help generate a sustainable income.

Our Portfolio Analysis tool can help clients to understand the composition of their portfolio and help them identify where changes might need to be made.